Working Paper: NBER ID: w22510
Authors: Marc Dordal i Carreras; Olivier Coibion; Yuriy Gorodnichenko; Johannes Wieland
Abstract: Countries rarely hit the zero-lower bound on interest rates, but when they do, these episodes tend to be very long-lived. These two features are difficult to jointly incorporate into macroeconomic models using typical representations of shock processes. We introduce a regime switching representation of risk premium shocks into an otherwise standard New Keynesian model to generate a realistic distribution of ZLB durations. We discuss what different calibrations of this model imply for optimal inflation rates.
Keywords: No keywords provided
JEL Codes: E3; E4; E5
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increasing the persistence or volatility of AR(1) risk premium shocks (C22) | longer average durations of ZLB episodes (E39) |
| longer average durations of ZLB episodes (E39) | raises the optimal inflation rate from 1.3% to 2.2% when moving from an average duration of 5 to 6 quarters (E31) |
| regime switching model (C22) | produces a distribution of ZLB episodes that is more aligned with empirical observations (D39) |
| regime switching model (C22) | yields a lower sensitivity of optimal inflation rates to average durations compared to the AR(1) model (C22) |
| higher levels of steady-state inflation (E31) | reduce the frequency of ZLB episodes (E52) |
| reduce the frequency of ZLB episodes (E52) | mitigate welfare losses associated with prolonged ZLB periods (E63) |